“Current Affairs Editorial – Tackling the economic slowdown”

Tackling the economic slowdown

G.S. Paper II: Indian Economy and issues relating to planning, mobilization of resources, growth, development

Context:
• India has witnessed an economic growth slowdown for five consecutive quarters, that is from late 2015-16 onwards.
• For a government that had promised to turn around the economy through decisive governance, this must serve as a wake-up call.
• But the hand of the government is tied up because it has to stick to the fiscal roadmap.
• An economy that has been slowing for five quarters is unlikely to turn around quickly. Also, it may not be able to do so on its own.
• The Government can find a solution in greater public investment which must now flow into the repair and reconstruction of infrastructure.
• The immediate thing to do is to expand public investment in infrastructure.

Why Slow Growth should concern us:
• Since 2014 the government has focussed aggressively on the supply side by making it easier for private firms to produce.
• But we are now facing a demand shortage in the economy.
• Growth matters in India as a large number of persons have to make do with far too few goods and services as it is, which is how poverty is defined.

Relation between Slow growth and Public Goods:
• These goods also include public goods or goods that are accessed by the entire populace of a country, such as parks, roads and bridges.
• Since these public goods are provided by government, the government needs tax revenues to supply them, and these depend upon national income.

Relationship between Slow growth and Unemployment:
• A demand for labour exists only when there is a demand for goods. So growth is necessary if employment is to be assured.
• In India we have a pool of unemployed persons to absorb.

India’s youth bulge may turn into a Demographic Burden:
• But India also needs to provide employment to youth, famously termed as the Demographic Dividend, continuously entering the labour force.
• From this point of view, the slowing of the economy is a source of concern.

Between Fiscal Stimulus and Structural Reforms: What to choose?
• The government itself has not ruled out expansionary macroeconomic policy.
• But other stakeholders have discouraged fiscal profligacy and want instead structural reforms.

The claims and the extent of Reforms in India:
• Reforming is what all governments have been claiming to do for more or less a quarter of a century now.
• Since 2014, in particular, “the Ease of Doing Business” has received great attention from this government.
• The argument made for land and labour market reforms as a pre-requisite for accelerating growth today is very vocal in India today.

Where we need real reforms: The Chakravyuha challenge in the Indian Labour Market:
• It would be correct to say that labour market reforms have not been taken up yet in Parliament and that exit is necessary for a dynamic economy.
• Labour laws in India make exit difficult, and complying with requirements with respect to the hiring of labour is time consuming and therefore costly.
• A possible effect of the Labour reforms could be that the share of manufacturing will rise in the GDP component of the country.

Where we need real reforms: Reforming the Indian Land Market:
• It is when it comes to the land market that the argument for more reforms is obvious.
• Apart from restrictions on conversion of agricultural land, no policy stands in the way of private parties transacting with one another.
• An intervention that government in India should avoid is facilitating land acquired for industry to be alienated from manufacturing activity.
• The government must ensure as much land to private industry as they seek, though at a price, is bad economics.
• This is an intervention out of sync with a market economy.

The Real Reason for slow growth: Declining Capital Formation.
• Capital formation as a share of output has declined almost steadily for six years now.
• In 2014 – 15 it rose slightly, but soon resumed its sliding at a faster rate.

How Low Capital Formation affects Public Capital Formation:
• Low Capital Formation contributed to the downward trend by reversing the rate of growth of expansion of public capital formation from 2015-16.

What drives the Economy forward? Public and Private Investments
• It is capital formation, or investment, that drives growth in the economy.
• Because, investment is an immediate source of demand as firms that invest buy goods and services to do so, but it also expands the economy’s capacity to produce.
• Of the two main sources of investment, namely private and public, the first has been depressed for some years.

Slowing Economy and Private Investment:
• In a slowing economy, private investment is unlikely to revive in the absence of some external force.
• This is so as private investment involves committing funds for a long period under uncertainty.

When To Step Up Public Investments in an Economy:
• It is for this reason that economic theory prescribes the stepping-up of public investment when private firms are unwilling to invest more.
• Increased public investment increase demand and quicken growth.
• But the increased public investment may be expected to encourage private investors, as the market for their goods expands.

Advantages of Increased Public Investments:
• Other things being the same, increased public investment leads to a higher deficit, which is the gap between the government’s expenditure and its receipts.
• There is not much currency in the argument that government run a deficit for fear that it may become inflationary.

The fear of Inflation due to Increased Public Investments:
But in any such assessment, the increase in inflation must be offset with the increase in growth that would have been achieved due to greater public investment.

The Constant source of Inflation in India: Shortage of Agricultural Goods:
• In India, the increase in inflation that could come with higher growth would be due to the shortage of agricultural goods.
• Any plan for increasing the rate of growth in India, not just at the present moment but in general, must reckon with agricultural shortages.
• It is right to be concerned with the consequences of a fiscal stimulus by increasing the public expenditure.

The Correct Approach: Balancing the budget based on Growth Cycle:
• The correct approach would be to aim to balance the budget over the growth cycle.
• The deficit may be increased as the economy slows and contracted as the economy quickens.
• To object to an increase in the deficit irrespective of the state of the economy is to be irrational.

Way forward through a direct and potent measure: Take up Repair and Reconstruction of Infrastructure:
• Repair and reconstruction of India’s creaking infrastructure is the direction in which greater public investment must now flow.
• It is the most direct and potent measure that can be undertaken to address the slowdown the economy is experiencing.